A recent Vox eBook examined the potential issues facing various EU members when it comes to negotiating with the UK over Brexit. This column, taken from the eBook, examines Spain's negotiating position, including the possible stumbling block of Gibraltar.

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Brexit was a bombshell in Spain, its impact surpassing that of the general election which the country itself was holding three days later. Spaniards were stunned, worried about both the political and economic implications. Indeed, according to a Bertelsmann study of public opinion in large European countries (De Vries and Hoffman 2016), Spain was the country most against Brexit, with 64% of Spaniards declaring their position against it.

Unlike in other countries, the worry does not extend to a potential contagion into Spain’s politics. Among the mainstream political parties only one, Podemos, has flirted with Euro-scepticism (it once advocated leaving the Euro, as the Communist Party, one of its allies, still does). In fact, Spaniards have historically been among the strongest supporters of the European integration project (as well as among its main beneficiaries). As of 2016, 74% of Spaniards would vote ‘Remain’ if a similar referendum were held in Spain (De Vries and Hoffman 2016). However, Spain is worried about the future, and there is generalised concern about what Brexit may mean for Spain and for Europe. There are several reasons for this.

First, the UK-Spain relationship is the picture perfect illustration of the economic and political benefits that the EU, and the Single Market, can bring about, as I show in the next section – large flows of people in both directions, as British retirees seek out Spain’s quality of life and Spanish youth seek jobs and education in the UK; a peaceful, workable non-solution to the Gibraltar question, one of the most intractable territorial disputes left in Europe; large flows in trade of goods and services in both directions; and very large foreign direct investments by companies from both countries in the other. Untangling this web, as a hard Brexit would require, would be very costly to companies and workers all over Spain (and, of course, the UK). This economic cost is a particular concern given that the country is just coming out of a brutal economic crisis and levels of unemployment are over 20%.

More broadly, Spain wants a strong Europe. All political parties in the Spanish parliament are in favour of strengthening the Union, including deepening the Eurozone towards a fiscal union, common border and security policy, immigration policy, and so on. Spaniards worry that Brexit may be the beginning of the unravelling of a European project that has been a crucial pillar of Spain’s return to democracy and prosperity.

Finally, Spaniards’ worry also has a more local angle, as the referendum has potential – albeit unclear – implications for the regional dispute in Catalonia. A growing minority of Catalans have been agitating for independence for Catalonia. The way Europe deals with a potentially independent Scotland’s likely accession request in the aftermath of Brexit is being closely followed in Spain, even though all parties acknowledge the crucial differences between the constitutional and legal status of Scotland and Catalonia.

In spite of these worries, some in Spain see opportunities in Brexit. Most notably, the Spanish government sees Gibraltar as a colony of the UK on Spanish soil. There is unconcealed glee in the Spanish conservative government about the broad support that remaining in the EU has commanded in Gibraltar, and many in government see a unique opportunity to solve an issue that has enormous symbolic value to many Spaniards. Spain will also fight to attract the financial service industry and manufacturing jobs that may abandon the UK post Brexit.

A highly integrated market: The four freedoms in action

As we pointed out above, Spain is one of the clear success stories of the European integration project, and the Spain-UK relationship in particular features a highly integrated market, with benefits from trade widely spread among the entire population. Spanish and UK citizens have taken advantage of the four freedoms that are basic to the Single Market: free movement of goods, services, people and capital.

Free movement of people has resulted in huge bilateral migration flows. Migration will be the crux of the negotiations, as it was the key driver of the Brexit vote and limiting freedom of movement within the EU is likely to be the one request by the UK that is most difficult for the EU to accept.

And yet the picture of bilateral flows between Spain and the UK could not be further from that painted by the ‘Brexiteer’ politicians Boris Johnson, Michael Gove and Nigel Farage. In fact, Spain has quite an unusual position among European countries in that the balance of immigration is “favourable” to the UK – many more Brits choose to live in Spain than Spaniards in the UK.

In the age of EasyJet, the estimates vary hugely, but Eurostat estimates that 306,000 UK-born citizens have Spanish residence. However, if one also counts those who live for part of the year in Spain, the figure reaches a stunning figure one million full- and part-time residents, according to a study by the Institute for Public Policy Research (Finch 2010). On the other side, official Spanish Statistical Institute (INE) estimates suggest that 102,498 Spaniards live in the UK, although again the true number is likely much larger.1

The potential issues at stake that must be sorted out in negotiations for all of these citizens are many. From access to health care, to housing and work permits, to visa-free travel, Brexit may change it all, and according to multiple press reports, it appears to be a source of anxiety and even anguish, particularly for less mobile UK pensioners in Spain.

The freedom to trade goods and services has resulted in large bilateral flows and a substantial trade surplus for Spain. The most recent data (released by ONS in March 2016) show that Spain exported goods and services to the UK worth a total of £24 billion in 2014 and imported £14.8 billion.2 Thus Spain had a bilateral trade surplus of £9.2 billion, well over 1% of Spanish GDP (depending on the volatile exchange rate). After Germany (which had a £25 billion surplus), this is in absolute terms the largest positive imbalance with the UK of any country in the EU, and the fourth largest worldwide after Germany, China and Norway.

This overall surplus is composed of a surplus in the trade of both goods and services. The UK is the fourth largest market for Spain’s goods and services, accounting for 7% of the total. In terms of goods trade, the UK is particularly important for the exports of transport equipment (20%), machine tools, chemicals, metals, mining, and vegetables.

The large services surplus is due mostly to tourism. The UK is the main buyer of Spain’s tourism, with 15.8 million British tourists visiting Spain in 2015 and the UK accounting for 21.1% of total tourism income (Greenwood 2016).

Thus it is hard to overstate the risk that a ‘hard Brexit’ would pose, through trade, for Spain’s economy. No country is more vulnerable than Spain to the trade disruption, given the trade surplus (in GDP terms), and no country has a larger interest in the softest of Brexits. There is a large downside for both countries from any disruption to all of these flows – and no conceivable upside – from the negotiations. All that remains to ask is how bad will the damage be.

Freedom of capital movement has resulted in enormous FDI flows. According to a recent report (Greenwood 2016), the UK is the main destination for Spain’s FDI, accounting for 14% of the total outflow. This outflow has been directed particularly towards finance, telecoms and electricity. Spain has the largest investment in the UK’s financial services of all EU countries, and is second worldwide after the US, through two of the largest Spanish banks (Santander and Sabadell). Almost one out of every five pounds of foreign investment in the UK’s banking sector is represented by these two Spanish banks (17%, according to Greenwood 2016). Both banks have huge exposure to the UK through their affiliates, with these affiliates accounting for around a quarter of their assets and profits in Q1 2015.

The flow in the opposite direction is also large. The UK is the fifth largest investor in Spain, focusing on telecoms and tobacco (Greenwood 2016).

In sum, the relationship is a clear success for the UK-led project of a European Single Market, and one that will be expensive for both parties to unravel. For the UK, the highest human and economic cost will be from unravelling the freedom of movement (with significant potential losses to large UK contingents of residents in Spain). For Spain, the main potential vulnerabilities are in trade and FDI flows.

For both, potentially enormous vulnerabilities derive from potential financial and macroeconomic turbulence as the new steady state is reached. This has the potential to be a really nasty transition.

Spain’s priorities

Spain has three priorities, which are not necessarily compatible.

1. The politics: Preserving the Union.

As one of the most pro-European countries, Spain is committed to preserving and deepening the Union. This obviously suggests that Spain will support the European Parliament involvement and the European Commission´s leadership in the negotiations, avoid obvious bilateral discussions (quiet discussions, one imagines, must be always taking place), and push for an arrangement that falls neatly into existing categories – that is EEA or Switzerland, or if not, Canada. Thus political considerations would lead us to expect Spain to militate strongly against intermediate “soft” solutions such as that proposed by Pisani-Ferry et al. (2016).

2. The economics: Preserving the tangled web of the four freedoms.

The economics point in quite a different direction. As we have seen, the UK-Spain relationship is a very tangled web indeed, with large benefits to both parties, and, in trade of goods and services, particularly to Spain. To disentangle it would involve massive costs. A hard Brexit is emphatically not in the interest of either the UK or Spain. The economics (unlike the politics) suggest that Spain would be likely to militate against any disruptive Brexit and look for middle of the road solutions. However, this pragmatism is unlikely to extend to all British aspirations. In particular, Spain has a very recent memory of large outward migration flows (throughout the period of the dictatorship) that have recently been revived again with the crisis, and it will be extremely difficult for the government to accept a limitation to the freedom of movement.

3. Gibraltar: A potential make or break issue.

Gibraltar, a small peninsula with large strategic value, was lost by Spanish after its capture in 1704, during the War of Spanish Succession, by an Anglo-Dutch fleet and was ceded to Britain by the Treaty of Utrecht in 1713. After multiple wars and sieges, it has become a highly succesful enclave within the EU with a high degree of self-government. The status of Gibraltar, officially a colony, is nevertheless contentious, as is the status of its airport, which was built on land that the Treaty of Utrecht set as neutral territory.

The management of this dispute has been greatly facilitated in the context of the EU. The border between Spain and Gibraltar was only reopened in 1985, and since then trade and people have flowed freely between the two territories. Gibraltar has become the second richest territory in the Union.

The current Spanish Minister of Foreign Affairs, José García-Maragallo, has stated clearly – and his position has been echoed by the Spanish Permanent Representative to the United Nations on a recent meeting on decolonisation – that after Brexit a new understanding must be found, and that it must involve co-sovereignty of the UK and Spain over Gibraltar. In his words, ”they will have to choose between British outside the Union or Hispano-British inside the EU”. Only co-sovereignty will allow Gibraltar to have the treaties apply to it.

In the solution the Spanish government is pushing for, Gibraltar citizens would preserve access to the European Single Market, obtain both nationalities, and conserve a large degree of autonomy. Spain and the UK would be jointly in charge of defence, foreign affairs, border control and immigration. Crucially, the Spanish flag would fly on Gibraltar.3

How much of an obstacle this issue – tiny in terms of welfare for the two countries, but with huge symbolic value – may pose in the negotiations remains to be seen, but it is sure to have a considerable weight in them.

What can we expect Spain’s negotiating position to be?

From the perspective of its commercial, investment, and migratory interests, Spain could be willing to accept a soft Brexit, that is, a modified EEA with some governance mechanism for the participation of the UK in joint decision making.

However, Spain has been adopting a low profile in the international arena for many years now, and its Europeanism suggests that it is highly unlikely to deviate from the position taken by France and Germany, and will thus demand that the Commission leads and the Parliament has a say in the negotiations, once Article 50 is invoked. Spain will likely be a disciplined soldier on the European side, and demand that access to the Single Market continues to require a commitment to all four freedoms, and most notably to freedom of movement of people inside the Union.

A potential stumbling block is Gibraltar. Everything we have heard from the Spanish government up till now suggests that it is unlikely any deal in which Gibraltar retains access in any form to the EU will be reached that does not involve joint (Spanish and British) sovereignty over the peninsula.

The Gibraltar issue highlights the likely result of the negotiation between the EU27 and the UK – the UK’s death by a thousand cuts. Every country involved in the bargaining has veto power, and every one of them is likely to have a shopping list – some issue that is important enough to block progress. For the Poles it may be freedom of movement, for the Irish it may have to do with Northern Ireland. The ability of the UK government to resist these demands, with the clock ticking, simply does not seem to be there.

As a result, the UK is likely to find itself, at the end of these two years, with a very bad deal. By the time 27 countries have finished putting together their “Yes, but what about Gibraltar?” like objections, the pro-Brexit politicians will either have to start explaining to voters the distance between the fantasy they invented and the reality, or be prepared to back off from Brexit.

Editor's note: This column first appeared as a chapter in the VoxEU eBook What To Do With the UK? EU perspectives on Brexit, available to download here.

Authors' note: In the interest of full disclosure: I am a Spanish citizen, my kids live in Holland, and my job is in London. Thus my life will be directly affected by the negotiations which are the object of this chapter, as will the lives of many other UK and European residents.

Even though the author is in charge of economic, industrial and innovation policy for the Ciudadanos Party in Spain, the analysis presented here is undertaken in a personal capacity as an academic observer and LSE professor. None of what is here written should be taken to be the position of the party or a recommendation of what it should do; it most emphatically is not. I thank Carles Casajuana, the previous Ambassador of Spain to the UK, for a useful conversation and Jesús Fernandez Villaverde for comments on the first draft. All errors are my own.

[3] For a good description of the positions of Spain and Gibraltar on these issues, see the article by Andrés Machado in El Mundo, “Picardo repica a Maragallo: Ni en cuatro años ni en 4000 ondeara la bandera Española en Gibraltar”, 6 October 2016.

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Research Fellow with the Productivity and Innovation Programme, Centre for Economic Performance; Professor of Economics and Strategy, Departments of Management and of Economics, London School of Economics; and Research Fellow, CEPR